as your interest piqued when you heard about the introduction of gold exchange traded funds in the Budget?

Before you get sold on the idea, here's a lowdown on what they really are and what you can expect.

The essence of a mutual fund

An equity mutual fund invests in shares of various companies.

A diversified equity mutual fund may have shares of, say, 20 companies belonging to 10 sectors.

If you buy a mutual fund that invests only in one sector, it is a sector fund. So you may have a pharma sector fund that invests only in pharma companies or a healthcare sector fund that only invests in such companies.

When we talk of gold exchange traded funds, it means they are funds focused only on one asset: gold.

They do not derive their value from the share prices of various companies. Instead, they do so from gold.

The underlying asset is not equity, but gold.

How the unit price is determined

A mutual fund will sell units. Each unit will cost a particular amount, called the Net Asset Value.

In an equity fund, the NAV depends on the current market prices of the shares of the companies the fund has invested in, the amount of cash the fund is holding and the number of units the fund has.

As the prices of the shares of the invested companies rise, so will the NAV.

Abroad, the practice with gold traded funds is that one unit represents one-tenth of an ounce of physical gold.

1 ounce	28.35 grammes
1 troy ounce	31.1035 grammes

So if there are investors in the fund who hold 10,000 units, that means the fund must have physical gold worth 100 ounces.

As the price of gold rises and falls, the value of the unit will move accordingly.

Just like a mutual fund, the value per unit will be the total value of gold held divided by the number of units, minus the expenses of the fund.

• Should you buy gold?

Does it make sense to buy gold?

Yes.

It is wise to have some amount of your money invested in gold. You could put it as anywhere from 5% to 10% of your total investments.

Gold is a hedge against inflation. As inflation rises, your rupee will buy you less than what it did earlier. But the price of gold will continue to rise. That means your investment in gold does not lose its value; its value could increase.

Come what may, gold is an international currency.

That is why in the face of war and terrorism, people tend to buy gold as a safety measure. Even if the value of your currency falls to nothing, gold will be linked to the international price. 

And even if no one wants your currency anywhere in the world, they will buy your gold.

• Buy a gold bar, not a necklace!
• Why jewellery is a bad investment

Does it make sense to invest in such a fund?

There are three ways of owning gold.

1. Buying the shares of mining companies.

2. Buying physical gold (gold bars or coins).

3. Investing in a gold traded fund.

• How to buy gold bars

Unfortunately, the first option is not really available. After all, only if mining companies go public (list their shares on a stock exchange) can you buy their shares.

From the other two, there are a number of factors to look at:

i. Convenience

The only area where a gold traded fund will score over owning actual gold is in convenience and actual storage. You don't have to worry about safety and keeping it in a bank locker.

ii. Cost

It may be cheaper to buy a few units of the fund if you cannot afford a gold bar. However, you will have to check and see if they sell minimum number of units or have a minimum investment criteria.

iii. Fees

When buying a gold bar, you pay the actual cost of the gold and a 1% sales tax. Look to see what fees are applicable when you buy from a mutual fund: entry fee, exit fee, transaction tax.

Why pay the mutual fund fees when there is no savvy trading being done? Or no expertise required of you?

Instead, buy a gold bar and sell it when you want. You will make a profit.

iv. Tax

Gold does attract capital gains tax. This should also be applicable for the gold traded mutual fund.

• Buying gold? You will be taxed?